Executives
Ron Sargent - Chairman, CEO
John Mahoney - Vice Chairman, CFO
Laurel Lefebvre - VP Investor Relations
Mike Miles - President, COO
Joe Doody - President, North American Delivery
Demos Parneros - President, U.S. Stores
Analysts
Matthew Fassler - Goldman Sachs
Danielle Fox - Merrill Lynch
Bill Simms - Smith Barney Citigroup
Joe Feldman - Telsey Advisory Group
Dan Binder - Buckingham Research Group
Colin McGranahan - Sanford C. Bernstein & Company
Mike Baker - Deutsche Bank Securities
Brad Thomas - Lehman Brothers
Brian Nagel - UBS Warburg
Staples, Inc. (SPLS) Q2 2006 Earnings Conference Call August 15, 2006 8:00 AM ET
Operator
Good day, ladies and gentlemen and welcome to the second quarter 2006 Staples Incorporated earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Ms. Laurel Lefebvre, Vice President of Investor Relations. Please proceed, ma'am.
Laurel Lefebvre
Good morning, everyone, and thanks for joining us for our second quarter 2006 earnings announcement. During today's call we'll discuss some non-GAAP metrics, such as return on net assets, to provide investors with useful information about our financial performance. Please see the Financial Measures section of the investor information portion at Staples.com for an explanation and reconciliation of such measures, and other calculations of financial measures that we use to analyze our business.
I would also like to remind you that certain information contained in this call constitutes forward-looking statements for purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicted by such forward-looking statements as a result of various important factors including those discussed or referenced under the heading, Risk Factors and elsewhere In Staples latest 10-Q filed this morning.
I'd also like to remind you that we've restated our 2005 results to reflect the impact of expensing stock-based compensation and will refer to those restated numbers when comparing our 2006 results to the prior year.
Here to discuss Staples Q2 performance and business outlook are Ron Sargent, Chairman and Chief Executive Officer; Mike Miles, President and Chief Operating Officer; and John Mahoney, Vice Chairman and Chief Financial Officer. Also joining us are Demos Parneros, President of U.S. Stores; and Joe Doody, President of North American Delivery.
Ron Sargent
Thanks, Laurel. Good morning, everybody. I'm very pleased to announce strong second quarter results today. The Staples team continues to make progress on our key growth platforms, driving record sales and earnings during the quarter. We're winning with our customers in all channels and we're profitably gaining market share.
Just to recap the headlines, our top line accelerated nicely during the quarter with total sales up 12% to $3.9 billion, as we're seeing the results of recent investments in growth. Sales growth in copy centers, our contract business, Staples brand and geographic expansion are just a few examples.
North American retail comps were up 4% with total sales growth of 10%. North American Delivery sales increased 17%. International top line grew 5% in local currency and 8% in U.S. dollars with a 1% comp in Europe retail.
Net income was up 19% to $161 million and EPS grew 22% to $0.22. Total company operating margin increased 30 basis points to 6.5%. Inventory turns increased to 5.8 times, as we continue to work hard on our supply chain programs. Return on net assets improved 120 basis points year-over-year to 13.2%, getting close to our goal of 13.7% as we remain focused on driving profitable sales growth, improving operating margins and getting more productivity from our assets.
Customer service metrics, they continue to get better. They reached all-time highs in both our retail and delivery businesses in North America; another indication that we're winning with customers across the board.
Finally, we're on track to reach our goal of 20% of sales from Staples brand products this year with help from new product launches and continued focus on quality and progress in our direct sourcing activities. In the Journal of Commerce's ranking of the top U.S. importers by volumes, Staples now ranks in the top 50 importers in the country.
Over the past several years, we've steadily improved both our operating margins and returns on capital. These results have allowed us to invest in ideas to grow our top line faster and gain market share. We've also worked hard to differentiate our business both in determines of product and service and we're seeing good traction from these efforts as demonstrated by our strong comp growth, customer traffic and the terrific momentum that we've created in our delivery business.
We're making great headway on our three company-wide objectives for 2006. We continue to focus on industry leading execution, on building the Staples brand, and on growing our market share around the world.
We're clearly seeing results with market share gains in North America and improving results in our international business. Our solid performance in the first half of this year reflects the consistent execution of our associates and the steady progress we're making as we invest in new growth platforms.
I'll now turn the call over to Mike Miles to talk about our North American businesses.
Mike Miles
Thanks, Ron. Good morning, everybody. Let's start with the results for North American Retail. Sales for the second quarter were $2.0 billion, up 10% versus a year ago. Strong customer traffic drove 4% comps on top of 3% last year.
Comps and consumables were 5% driven by core office supplies, copy and print center and ink and toner cartridges. Durables comp’d 2% with particular strength in mobile computing and accessories.
Our copy center growth initiative continues to show terrific momentum. During the quarter, this high margin business comp’d double-digits and we're seeing a good return on our recent investments in training, technology and marketing. Customer service metrics remain strong and satisfied copy center customers are a driving force behind our improving complaints-to-compliments ratio.
Furniture improved in Q2 reversing the trend with good growth in chairs. We have focused on a higher quality chair assortment, driving a double-digit increase in average selling price. Efforts are underway to improve the rest of our furniture assortment as well, but fixing this category is going to take a little time.
We're seeing strong demand for laptop computers, and to make sure we sell a profitable basket along with the lower margin hardware, we've recently rolled out an improved approach to attachment selling to drive sales of higher margin input devices, power accessories, cables and cases. We've completed a major chain-wide reset of the category, enhancing the layout, signage and adjacencies of our mobility assortment to create an easy to shop and buy experience for our customers.
We've also provided additional sales training to our associates. As we focus on selling technology solutions to our customers, we're seeing strong demand for tech support and service. We're expanding our EMT program this year adding in-store technicians to augment our national in-office and in-home service.
Finally, our efforts to convert customers of the recently closed Office Max stores have begun to pay off and benefited us by about half a comp point in the quarter.
With the strength in high margin categories driving positive gross margin comps, and disciplined SG&A expense management across the board, North American Retails SBU income rose to $158 million, growing 30 basis points year-over-year to 7.8% of sales. We're very pleased with our results in controlling costs across-the-board, but particularly in terms of managing labor and distribution costs.
Turning to store growth, during the second quarter we added 13 new stores in North America with 11 stores in the U.S. and two in Canada, and closed one store in the U.S. We ended the second quarter operating 1,539 stores in North America and are on track to open around 100 new stores in North America this year.
We added ten new Dovers and remodeled 16 more stores to the Dover format, ending the quarter with 597 Dover stores. In addition to full scope Dover remodels, our stores team has done a very good job keeping the entire chain fresh and exciting to shop. We've already completed more than 2,000 retail projects so far this year including upgrades to our copy centers, refreshing our high volume and express stores and resetting the chain for our recent mobility initiative.
Our Dover format is very flexible, and allows us to make planogram changes more quickly and inexpensively. With our improved ability to execute store projects, 100% of our stores have received some type of remodel or planogram enhancement over the past year.
To give you an early read on the back-to-school season, we're off to a good start with strong response to our promotional offers in the earlier markets. Since our season runs deep into September and our biggest weeks are still ahead of us, it's still too early to call a season, but our stores have an appealing, colorful assortment this year and our supply chain team expects to deliver strong in stock performance throughout the season.
We've also launched two new TV ads featuring the Easy Button infused with the popular theme from one of our most successful campaigns, "It's the Most Wonderful Time of the Year." Running a national five-week campaign during high visibility programs like Good Morning America and Gray's Anatomy, the new spots emphasize how Staples makes it easy for parents and students to stock up on school supplies.
We also launched over 200 new Staples-brand products in time for back-to-school, featuring color coordinated products to jazz up lockers, classrooms and dorm rooms. While we are offering some great deals to our customers to drive traffic, we're also seeing a generally rational pricing environment, pretty similar to last year's competitive landscape.
The back-to-school selling season provides Staples with a tremendous opportunity to differentiate ourselves with great customer service. Going into the season, customer satisfaction scores are at an all-time high and mystery shop scores are well ahead of plan.
Our store teams are in a great position to deliver an easy shopping experience by maintaining high-end stock levels and a well-organized assortment late into the season when many other retailers are out of stock, hard to shop and essentially out of the back-to-school business.
Back-to-school is an important season for us, particularly in new markets like Chicago, since it gives us the opportunity to acquire new business customers who discover Staples for the first time when shopping for school supplies with their kids.
We continue to ramp up our programs with supermarkets, offering customers an assortment of national brands along with a broad selection of Staples brand office supplies. As of the end of Q2, about 1,200 supermarkets featured a Staples branded aisle. For the back-to-school season, an additional 1,400 supermarkets have a Staples branded back-to-school presence in their seasonal aisle for a total store count of about 2,600 locations during this critical consumer period. While this is still small in total dollar terms, this program extends our brand and our reach to new customers, adds incremental sales and delivers an attractive wholesaler profit margin.
In summary, our North American retail team continues to execute at a high level, improving service and delivering consistent results from our major growth initiatives. We're pleased with our continued success in driving customer traffic, impressive growth in destination categories like ink and copy center, and progress in improving customer satisfaction through our Easy service model.
Moving on to our North American delivery business, the NAD team delivered another terrific quarter of strong sales and earnings while making investments in the business to support its rapid growth. Year-over-year, sales grew 17% to $1.3 billion with strong top line growth in each of the three segments.
North American delivery achieved double-digit growth in each of our major product categories with chairs and computer furniture, ink cartridges and janitorial and break room supplies showing particular strength.
SBU income of $141 million, or 10.5% of sales increased 21% versus last year's second quarter. Strong leverage on many expense lines demonstrated advances in salesforce productivity, marketing efficiency and call center expense management.
These gains were partially offset by costs to open and ramp-up to full productivity our three new fulfillment centers in Chicago, Orlando and Atlanta as well as continued pressure from paper costs and fuel expense. The team delivered strong customer service scores with perfect order improvement rate helping to drive these excellent results.
Worldwide e-commerce sales in the second quarter were $1.1 billion, a 27% increase year-over-year. Electronic orders continue to grow reaching 91% of orders in the contract segment. Overall, North American delivery online sales volume for Q2 was 73% compared to 67% a year ago.
Taking a closer look at each of the three business units, Staples business delivery continued its strong sales momentum and margin growth. Its integrated and targeted marketing efforts for customer acquisition and retention continue to pay dividends. During the quarter we launched a new catalogue featuring Staples brand products only and customers are responding positively to our broad and innovative assortment.
We've been really pleased with the new Staples.com platform launched about a year ago, both in terms of customer experience and the flexibility the site gives us to keep making improvements. Our rate of converting visitors to the site to buyers is up 40%, much better than the 10% improvement we projected.
Today, more than 70% of SBD's orders are placed online and we've seen significant improvement in our Biz Rate scores for ease of finding product and the design of our site. Our investments in technology are concretely making the business better by driving higher sales and margins and we'll continue to upgrade those tools.
In our contract business, we are clearly winning with customers. We continue to acquire new accounts at a rapid pace, thanks to our unique sales model. Our hunter-farmer salesforce puts the right people in selling and account management jobs. Our sales model evaluates all the drivers of profitability and we share the savings with our customers.
We're also doing very well with share of wallet opportunities like copy and print and Jansan. Success in both acquisition and share of wallet continue to drive the highest top line growth and strongest margin improvement within the NAD portfolio.
Great service is another essential element of our success. Staples contract division's call centers were recently certified for the third consecutive year by J.D. Power & Associates and our contract team continues to do a great job working with customers to manage the impact of paper cost increases and higher fuel prices.
Quill also delivered excellent results during the quarter driving sales momentum and the highest margins in our portfolio through execution and great customer service. Customer acquisition remains strong. We are increasingly sophisticated about leveraging our database marketing expertise to customize offers and our customers are responding well to these efforts, driving strong growth in paper, office supplies, and technology.
To update you on our North American delivery infrastructure, we have three new state-of-the-art multi-channel fulfillment centers opening in the U.S. this year which improve our geographic coverage and replace five existing single channel buildings. Two of these new FCs in Atlanta and Orlando opened in the second quarter and we are now ramping up their production. The Chicago FC is on track to open in Q3.
While bringing on new capacity hurts our expense rates in the short run it provides the capacity to sustain our growth and ensures continued great customer service. We expect continued expense pressure in Q3 from these new FCs, but at about a rate half as much as we absorbed in the second quarter.
Our supply chain initiatives in NAD are also progressing well with two major projects launched. We'll go into more detail on these at our upcoming investor conference but we've already begun to see improvements in reducing inventory while maintaining strong performance in our perfect order metric.
Initial project is aimed to reduce inventory storage requirements and current logistic expense levels, with the goal to improve gross margins and inventory turns.
With that I'll turn it back over to Ron to talk about international.
Ron Sargent
Thanks, Mike. Sales for the second quarter in our international segment were $510 million, that's up 5% in local currencies and 8% in U.S. dollars versus Q2 of last year. SBU loss was $7.7 million reducing last year's second quarter loss by about a third in our seasonally weakest quarter and we expect to see a continued improvement in the second half.
As we focus on how to win with customers, we're beginning to see steady improvement in key performance indicators in our European business units and we remain confident that we'll see continued progress throughout the year and beyond.
In retail, we reduced our operating loss year-over-year, same store sales increased 1%. U.K. store traffic remained relatively weak with categories like computers and accessories still soft. After focusing on fixing the business operationally during the first half of the year, we're much more confident in our in-store execution and the health of our supply chain and we will now begin to invest in marketing to drive small business customer sales.
Store fundamentals in the U.K. including in-stock purchases and our rewards program, owned-brand initiatives all continue to improve. Customer satisfaction is also dramatically better with customer compliments now outnumbering complaints.
The other countries in our retail portfolio performing well and are getting good traction from our marketing efforts. In terms of store growth, we ended the quarter with a total of 262 stores in Europe, opening two stores in Portugal and one in Germany.
On the delivery side, operating income improved year-over-year. In our French catalogue business we're seeing early indications that customers are responding well to our marketing efforts. Improving retention trends and a growing customer base make us optimistic that momentum is building. We continue to invest in loyalty programs, a stronger web offering, owned brand, and systems to build a solid foundation in France.
Spain and Italy are growing rapidly with improved profitability and our focus on driving share of wallet and customer retention are paying off across all geographies.
Turning to other markets, China and South America, they're performing on plan with rapid market share gains. Both businesses incurred a small loss during the quarter as we continue to invest in growth. During the second quarter we also announced plans to enter the Taiwan market with a joint venture with UB Express establishing a platform for Staples to build a strong presence in Taiwan.
So overall, we're making progress in our international businesses and we're encouraged by improvements in execution and customer acquisition, but we still have a lot of work to do to transform our European business into a high margin growth engine.
Now, let me turn it over to John Mahoney to review our financials and our outlook.
John Mahoney
Thanks, John. Good morning, everybody. I'll spend the next few minutes reviewing the financials and give some additional color on what's driving our results, then provide some guidance on our expectations for the third quarter and the full year.
Revenues of $3.88 billion were up 11.8% versus last year's second quarter. Excluding currency benefit in our Canadian and international businesses, sales grew 10%. Gross profit margin decreased by 24 basis points to 28.26% during the quarter. Profit margins were up slightly in North American Retail, so this decline was primarily a result of the expenses associated with our three new delivery fulfillment centers and to a lesser extent, paper cost increases and higher fuel expense in our North American delivery business.
Operating and selling expenses at 17.14% of sales for Q2 were 38 basis points favorable versus last year's second quarter. This reflects tight expense control across the board, including leverage in our store labor and marketing expense, driven by higher marketing effectiveness in North American Delivery.
Turning to general and administrative expense, G&A leveraged by 18 basis points for the quarter to 4.54% of sales, reflecting solid expense control and early success in G&A reduction initiatives, somewhat offset by higher stock compensation expense.
Moving on to the balance sheet, inventory increased year-over-year only slightly less than sales, but about $40 million of the increase is due to foreign currency rates. We've invested in technology inventory as part of our mobility initiative and to ensure the success of our plan to be first to market in back-to-school this year, we've brought in inventory to support our early back-to-school advertising. Moreover, investing in inventories is an example of our willingness to invest in assets to drive growth while still improving productivity.
Total inventory turns were up 16 basis points versus last year, to 5.77 turns. We're sustaining our inventory turn improvement through ongoing focus on the components of our summit programs in both retail and delivery.
Return on net assets for the year improved to 13.2%, up 120 basis points compared to the end of the second quarter a year ago. Remember that we've restated RONA to reflect the impact of stock-based compensation to provide metrics on a consistent basis. We expect our drive our RONA to 13.7% this year, reaching our long-term goal 200 basis points above our long-term cost of capital.
Our liquidity and financial resources remains strong. At the end of the second quarter, Staples had $1.9 billion in liquidity, including cash and short-term investments of just over $1 billion and available lines of credit of about $840 million.
During the second quarter, we repurchased 7.8 million shares under our current $1.5 billion stock buyback authorization, bringing our total repurchases so far this year to about $338 million and total repurchases under the current authorization to just under $500 million with about $1 billion remaining. Note that our diluted weighted average shares outstanding declined by more than 7.8 million shares year-over-year for the quarter, as a result of our repurchase program offset by stock option exercises.
Year-to-date CapEx came in at $254 million, up from the $174 million we spent for the same period in 2005. As returns have improved we've been willing to invest in capacity and growth and this year's CapEx increase reflects investments in IT, our store base, and the three fulfillment centers we're opening this year to ensure continued rapid growth in NAD.
With operating cash flow of $129 million, year-to-date free cash flow is negative $125 million. In addition to the higher inventory levels I've discussed, you'll see about $150 million swing in the accounts payable line on the cash flow statement. This reflects the timing of purchases and related vendor payments in the second quarter, as we bought product to launch our back-to-school season earlier and purchased more technology product to rollout our mobility initiative.
We bought a significant amount of inventory a month earlier than last year so the timing of payments in Q2 of this year versus Q2 of last year accounted for the majority of the swing. Based on about $500 million in planned capital expenditures for the full year we expect free cash flow generation in the range of $700 million this year.
In terms of our expectations for the third quarter, we expect to achieve earnings per share growth in the range of 15% to 20% in line with current analyst estimates. On the top line, we expect low double-digit growth.
This implies a low single-digit comp in our North American retail business, mid-teens growth in North American delivery and slightly positive sales growth in local currency and international. Average shares outstanding are expected to be about 740 million.
In terms of our expectations for full year 2006, we expect to be at the high end of the range of 15% to 20% earnings growth guidance we previously provided. We expect low double-digit growth for the total Company on the top line, including new store growth in our North American Retail store base and a positive, low single-digit comp. For North American delivery, we expect to grow revenues in the mid-teens and in international revenue growth should be slightly positive in local currency.
Thanks for your time this morning. Now I'll turn it back to our conference call moderator to line up the Q&A.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question comes from the line of Matthew Fassler - Goldman Sachs.
Matthew Fassler - Goldman Sachs
Thanks a lot. Good morning. Just a couple of quick questions here. First of all in North American retail, your traffic has been increasing pretty consistently quarter in and quarter out. Could you give us a sense as to whether the acceleration in comp revenue growth reflected a traffic acceleration or some pick up in ticket as well?
Ron Sargent
Yes, I'll ask Mike to give you a little more detail.
Mike Miles
Hi, Matt. The traffic has been driven a lot by our copy center growth and the successful ink program we've got which is driving good traffic into that destination category and that is the primary driver of our comp sales and, in fact, in terms of quarter-over-quarter, drove the comp improvement that we had in the second quarter.
Matthew Fassler - Goldman Sachs
Is ticket up or down in the retail business at this point?
Mike Miles
Ticket is down slightly in North American retail.
Matthew Fassler - Goldman Sachs
Is that largely a function of the copy center in the mix?
Mike Miles
It's partially a function of that. As you know, the copy center is a lower ticket than the store average and that's probably the single largest driver in that slightly down ticket.
Matthew Fassler - Goldman Sachs
Mike, just to be clear, is furniture up or down in absolute terms? It sounds like it got better than it was but is it still declining year-to-year?
Mike Miles
Furniture is flattish for the quarter.
Matthew Fassler - Goldman Sachs
Finally, Ron, on Europe, clearly your losses shrunk on a year-to-year basis. If you look at the numbers from a couple years ago you did make money in the second quarter. I'm curious how Europe is tracking versus your expectations for the recovery there?
Ron Sargent
Well, Matt, just to give you my perspective, I feel like we're making progress but as far as I'm concerned, we're not making progress fast enough. We're seeing some improvements in both our retail business as well as our delivery business.
I think the European economy feels a little better. When you look at our largest countries, the U.K. and France, they continue to improve, albeit more slowly than I would like. I feel like we're putting one foot in front of the other, I think we're going to make progress in each of the next two quarters so that the second half is going to continue to show improvement year-over-year.
Q2 is always our weakest quarter, but we do plan on getting back to making money in the second half of the year and we'll show some progress certainly year-over-year.
Matthew Fassler - Goldman Sachs
Thank you very much.
Ron Sargent
Thanks, Matt.
Operator
Our next question comes from the line of Danielle Fox - Merrill Lynch.
Danielle Fox - Merrill Lynch
Thanks. Good morning. In the second half of '05 you stepped up P&L investments in copy centers, labor and the Chicago market entry. In the second half of this year how should we think about those expenses? Do they decrease or do they simply not increase as sales grow?
Ron Sargent
Let me ask John to answer that one.
John Mahoney
Hi, Danielle. We've pretty consistently invested in growth ideas throughout the business. Last year it was copy center and some of the other things you mentioned. We continue to want to invest in the sales force in NAD, in service in our stores and a number of projects; some of which we've talked about, some of which we'll talk art more in the future.
I think you can expect us to maintain our performance along the lines we've described, while at the same time continuing to invest both P&L and capital dollars to grow the business longer term.
Danielle Fox - Merrill Lynch
What was the sales impact from higher paper prices? Was it accretive to particularly that 5% supplies comp and did it add to the growth at the delivery business?
John Mahoney
Danielle, unit growth in paper is actually down a little bit, so it almost offset the increase in paper prices. I would say that the paper comp is not material to the overall comp.
In the NAD business, as you know in the contract piece, the pricing trails the market a little bit as prices are based on a 12-month rolling average, and so the price wasn't really significant there as well. But the same trend also exists in NAD in that units are slightly down and I think a lot of our success has been in trading customers up to better quality papers.
Danielle Fox - Merrill Lynch
So from a profit perspective at NAD, the best scenario for prices would be simply a leveling off so that you could catch up on the margin?
John Mahoney
I think stable prices are probably the best thing over the long run. As prices go up and down, we have a little bit of improvement on the way down, a little bit of weakness on the way up so overall we would prefer stability to anything else.
Ron Sargent
Although I'm not sure we're going to see stability. I mean when you look at paper costs, we've seen three increases in cut sheet paper this year, so our costs probably year-over-year are up 20%, 25% and its been driven by a lot of things.
When you look at the paper industry, they're operating at a high level, they've got reduced capacity, their freight costs are up. Year-to-date they've taken out about 10% of the industry capacity out of the system and it looks like over the next year, there are plans to take out another 6% or 8% out of the industry capacity as well. You couple that with the fact that imports are down, exports are up from the U.S. and I think higher paper prices and costs are going to be with us for a long time. I think our challenge -- and I think we're doing a pretty good with that challenge -- is to pass those paper increases along to our customers.
Danielle Fox - Merrill Lynch
Thank you.
Ron Sargent
Thanks, Danielle.
Operator
Our next question comes from the line of Bill Sims - Citigroup.
Bill Simms - Smith Barney Citigroup
Thank you. Good morning. Ron, your European business certainly showed impressive growth during the quarter, presumably reflecting both the success in your recent investments and pick up in the economic activity in Germany, France and some other continental countries.
Given the outlook for a rise in interest rates in Germany, and the potential for higher taxes, how should we look at the outlook for Europe for the remainder of the year in the international business? You've guided to slightly positive. What are you suggesting in that guidance?
Ron Sargent
I'm not trying to guide to any particular level of profitability. I think what we said last year was that I didn't do a great job in providing guidance for 2005 so I wasn't going to provide a lot of guidance for 2006.
I guess my commitment is that we're going to be showing improvement year-over-year in the third quarter, we're going to be showing improvement year-over-year in the fourth quarter. But in general, I'm feeling a little more optimistic about our European business.
You referenced Germany in particular; Germany is really one of our success stories. I would guess that we're probably one of the few American companies making money in Germany and we're making more money each quarter.
So I'm kind of encouraged about our business. I think France seems to be getting back on track, we're starting to see some indications we can grow that business, and the U.K. the investments over the last six, nine months have really been just getting operationally right and now that we're operationally right, we'll be spending some money on marketing to grow the top line.
Having said that, I think Europe is about 13% of our sales, this quarter, none of our profits. But our view is that we think Europe is going to be a long-term growth vehicle. It's probably not going to affect us significantly in the next couple of quarters, in the next few years; but when you look five years from now we expect Europe to be a high performing part of our Company.
Bill Simms - Smith Barney Citigroup
Thank you. And just one follow-up. Last year the drag you saw in your U.K. business was partly tied to distribution problems you had there. Are you suggesting that you're going to spend the equivalent in marketing dollars to offset the potential benefit you would get from profit expansion there?
Ron Sargent
I'm not sure that I can parse it that carefully. When you look at all the moving parts, I think if you adjust for last year's one-time cost, our U.K. business didn't make any progress this year during the second quarter, which is in contrast to the first quarter where we saw some good improvement in Q1, and I think we'll see some good improvement in Q3.
In terms of the percentage of marketing spend versus the percentage of one-time cost, I don't think it's going to be a one for one. I think we're going to be spending less than our one-time costs were.
Bill Simms - Smith Barney Citigroup
Very good. Thank you. Good luck.
Ron Sargent
Thank you, Bill.
Operator
Our next question comes from the line of Joe Feldman - Telsey Advisory Group.
Joe Feldman - Telsey Advisory Group
Thanks. Hi. Good morning, guys.
Ron Sargent
Good morning, Joe.
Joe Feldman - Telsey Advisory Group
Question about the online conversion rate. You'd mentioned that it's about 40% versus a plan of 10% and I was just wondering what you think you're doing to drive that? Is there anything online that you're doing or how do you get that?
Ron Sargent
I'll ask Joe Doody who is responsible for our North American delivery business to answer that one.
Joe Doody
I think it's just making it an easier shopping experience for our customers and really understanding how they're going about shopping for our products and making sure that we're doing everything we can to make it easy for them. Fewer clicks, fewer steps along the way. Simplifying the process.
Joe Feldman - Telsey Advisory Group
On the competitive front, are you seeing anything different? Wal-Mart continues to be a back-to-school force. We hear Sam's Club is adding 8,000 SKUs to their assortment and obviously there's the Office Depot and Office Max. Anything new that you guys are seeing beyond that?
Ron Sargent
Frankly, no. Let me ask Demos Parneros, who would probably feel it most acutely being on the retail side, to answer that.
Demos Parneros
I don't think there's anything particularly new going on other than at this time of the year, it's back-to-school, everyone is in the game. I think you mentioned Sam's, Wal-Mart, the normal folks, Kinko's -- I mean, everyone's in the game so it just makes for a more competitive season and really ongoing business after back-to-school as well.
Joe Feldman - Telsey Advisory Group
Got it. The last thing I wanted address is with China and South America, I know they're still relatively new businesses and you are losing some money there but when are you guys hoping to see a profit there? Is that late '06 or is it probably next year?
Ron Sargent
No. I'm not even sure it's going to be next year because our plan in these emerging markets is really to grow the top line as quickly as we can, as rapidly as we can while still running the businesses in kind of a breakeven mode.
I don't think China and South America are going to be significant contributors to our profits in the next few years. I think you look five years down the road you'll start to see some significant impact from the profitability. But really, the story there is growing, growing the business as rapidly as we can while still making a little money each year.
Joe Feldman - Telsey Advisory Group
Got it. Great. Thanks, guys. Good luck.
Ron Sargent
Thank you, Joe.
Operator
Our next question comes from the line of Dan Binder - Buckingham Research.
Dan Binder - Buckingham Research Group
Why do you think given the strong supplies comp in retail that units of paper were down?
With basically a lot of the agents of production going up in price, is there any kind of real inflation in the comp that we're seeing in paper or otherwise?
Lastly, I'm not sure if you commented specifically on technology comps, I know you said durable comps were up 2% but was technology up a similar amount?
John Mahoney
Okay I'll start on paper. I think the customers, as prices go up they're being a little bit more careful about paper usage, they're also selecting higher quality papers so the number of times you print a document is probably fewer than it used to be when paper was a little bit cheaper. I don't think that it reflects anything other than the sensitivity to price.
Overall, our portable computers, our laptops, were extremely high comp, better than anything else in the durable category. Durables overall were 2% which obviously includes furniture, but I think that our core office supplies business still is what drives our business, we expect customers to replenish their supply closets and use the consumables that they need to run their business every day and that's really what drives the success of our business, day in and day out.
Dan Binder - Buckingham Research Group
And then just in terms of general price inflation across the store, are you seeing anything that's resulting in any significant contribution to comps?
John Mahoney
I'd say no. Over the last couple of years, we’ve seen small price increases from our vendors on categories that are impacted by petroleum products and overall, we've been able to pass those along. But it's not a significant contributor to our comps.
Ron Sargent
I mean if you look at technology it's probably gone the other way for deflation.
Dan Binder - Buckingham Research Group
I know Staples has cited their merchandising as being the primary issue of furniture softness at retail and you've made some improvements there this quarter, but I think industry generally has softened in furniture.
I'm just kind of curious, within the delivery business, I realize the comp is very strong and maybe it's hard to get a good read on it given all the acquisition of accounts that you've had. Are you seeing any kind of change in the rate of furniture growth from recent quarters?
Joe Doody
No, we haven't. We've had pretty strong furniture business over the past several quarters, but we've got a big opportunity there, Dan. It's not a big part of our overall business.
We still have a relatively small share of wallet of our customers, a small percentage of our customers that actually buy furniture from us. That's clearly the case in contract more than any of our businesses, so we have an opportunity to continue to grow furniture at a faster rate than our overall growth and that is my expectation.
Mike Miles
I think that's true in retail as well. Furniture is such a small part of our business that the macro trends are almost not as important. It's a little bit like the copy business where you've got a very slow growth category overall but where there's a huge opportunity for us to gain share and achieve a higher share of wallet from our existing customers and I think that's the dynamic that we're trying to drive both in delivery and in retail.
Dan Binder - Buckingham Research Group
Last question. With the expectation that paper prices are going to continue to rise and be with us here for a while, is there anything you can do in terms of the contracts that you're signing to factor that in, maybe be less aggressive on strict paper pricing over the course of a contract?
Ron Sargent
Dan, when you look at our contract business, we're always trying to tie them to an index that would move up in the case of paper price increases, move down when they come down and that's what we do; but in many cases you still have some lag time involved in that. So over the long haul, we'll get it back but going up, as John said, we'll be hurt a little bit; coming down we'll get helped a little bit in the short term.
Dan Binder - Buckingham Research Group
Okay, great. Thanks.
Ron Sargent
Thanks, Dan.
Operator
Our next question come comes from the line of Colin McGranahan – Sanford C. Bernstein.
Colin McGranahan - Sanford C. Bernstein
Thank you. Good morning. Two questions. First I wanted to focus on the fulfillment centers a little bit. If you could maybe help us understand a little bit what the costs look like during that ramp-up phase because clearly you're running below capacity. I'd imagine you have some dual capacity open during the ramp up.
As you transition to the three multi-channel fulfillment centers versus the five single channels, just trying to understand what that means to the expense structure of that NAD business, as well as just what kind of metrics you look at in terms of perfect order? What I'm really trying to understand is the magnitude both during the ramp-up phase and then the magnitude of the potential lower operating cost as you transition from five single channel facilities to three multi-channel facilities.
John Mahoney
Hi, Colin. That sounds like a math question so I better answer it, I think.
If you think about what we're trying to accomplish, we've got a delivery business that's growing mid-teens and so we need to increase capacity. When you open a new fulfillment center it increases our fixed cost levels so it's kind of a step level change; but at full capacity, the facilities would give us a lower cost per order than what we experience in our older facilities. So you should see a trend towards that step level change in fixed costs hurting us in the short run, giving us the capacity to grow longer term and ultimately improving the productivity and efficiency of our distribution costs over the long-term.
So there are certainly start-up costs. For example, writing off some assets in the old facilities as well as the things you mentioned like duplication of staffing and training. We get through those costs in the period of about six months or so. But beyond that there's still a little bit absorbing that capacity as those fixed costs are a little higher overall. Again, as we want to make sure we deliver great service to customers and have the capacity to sustain our growth, we think it's a wise investment to sustain the kind of growth we've seen long term.
Colin McGranahan - Sanford C. Bernstein
Just any comment on what kind of magnitude percentage-wise your cost per order would be in a state-of-the-art multi-channel facility versus a single channel facility?
Ron Sargent
Say that again, Colin?
Colin McGranahan - Sanford C. Bernstein
The savings in a state-of-the-art multi-channel on cost per order. John said lower cost per order in the new facilities.
Ron Sargent
It's relatively modest in terms of a cost per order differential. What we gain is the ability to be able to get a higher fill rate with our customers given the additional SKUs, a greater margin in terms of less use of wholesalers, or not being able to meet that out of that facility, out of that location; but on a cost per order basis it's just modestly less.
Colin McGranahan - Sanford C. Bernstein
I obviously expect the accounts payable to catch up here through the back half of the year which means you'll end up the year, the cash balance hopefully something approaching $2 billion. It's a lot of cash. What are you doing and why aren't you buying back stock more aggressively?
John Mahoney
Well, I think we've said very consistently that our goal is to maintain our capital structure in the range that it is today. We've planned some modest acquisitions in our cash forecasts and have not made acquisitions of any consequence over the last couple years, so that would eat into it slightly should we make some small acquisitions, in line with our announced strategy to do tuck-ins that earn their cost of capital in two to three years and to do it out of cash.
So I think we've continued to see better results on our working capital than we've had in our cash flow forecast, so there's at least a little of it that comes from performing better in working capital management than we plan in our cash flow forecast.
Overall, we think consistent share buybacks along with the dividend that we've seen are the best ways to drive shareholder value rather than one-time significant share buybacks at this point in time. So we're pretty pleased with our strategy to date.
Colin McGranahan - Sanford C. Bernstein
Okay. Thank you.
Operator
Our next question comes from the line of Mike Baker - Deutsche Bank.
Mike Baker - Deutsche Bank Securities
Can you, from just a higher level point of view discuss the macro-environment? I think one statistic that helps get that is what are you seeing for your existing customers and your large contract customers? Are you seeing growth there?
Ron Sargent
I think so. Let me ask Joe to answer that.
Joe Doody
Yes, we are seeing some growth there, Mike, but at the same time, our intention among our largest customers continue to drive more category penetration into their accounts to work with them, to drive greater utilization of our contract within their business to get a greater share off of wallet of their business. So it is at times hard to separate that, but we are seeing some very modest increase in their confidence and in their business.
Mike Baker - Deutsche Bank Securities
So with that very modest increase, how does that relate to last quarter six months ago, et cetera? In other words, are you seeing signs of any kind of slowdown? I know the small business optimism index has been down. Are you seeing anything that should concern you on the U.S. macro environment?
Joe Doody
No. From my standpoint across our delivery business, we're seeing market share gains and growth in small business, mid-size business and large business.
Mike Baker - Deutsche Bank Securities
Okay. Great. Good to know. On the gross margins, so a very nice performance all around but I think you guided to flat; it was a little bit below that. What surprised you there? It sounds like, correct me if I'm wrong, that gets better from here as you start to leverage some of these DC costs -- or is that correct assumption?
John Mahoney
That's correct, Mike. We did see both the costs associated with our delivery business, remember both paper costs and fuel costs are difficult to predict, that's probably the difference between flat and where we were. We do expect to see improvement as we bring online our facilities and get them some of the one-time costs behind us. We expect that we will not see a decline in gross margin on the second half of the year.
Mike Baker - Deutsche Bank Securities
Great. Thank you very much.
Ron Sargent
Thanks, Mike.
Operator
Our next question comes from the line of Brad Thomas of Lehman Brothers. Please proceed.
Brad Thomas - Lehman Brothers
Thanks. I think most of my questions have been answered now. John, you talked about how you're still seeing some benefits from your summit supply chain initiatives. Could you talk a little bit about anything specifically that you're still seeing there and how much more opportunity there still is?
John Mahoney
I think as you all know, in our retail business, summit began several years ago, included significant improvement to our processes throughout distribution centers and stores to make sure that we operated more effectively. That progress continues.
We also think that many of the efforts towards synchronization with our vendors continue as we drive better vendor performance, improve our ability to forecast, so there's lots of opportunity in our retail business from the things that we've already done.
In addition to that, some of our demand-driving activities should help us improve. If you look at world-class benchmarks we are well below world-class benchmarks for inventory turns, so we think that we will have continued progress in retail over the next several years.
Our delivery business on the other hand, we really have just begun our NAD supply chain activities and we see lots of opportunities in looking at the way we operate our fulfillment centers, both in terms of the way they're staffed, in the way they process orders, and also in the way we receive orders from customers for improving our fill rates, customer service as well as our asset productivity in NAD.
Brad Thomas - Lehman Brothers
Okay. Thanks. Just following up on the fulfillment centers, obviously, now you're shifting from five single channels to three multi-channels, but taking a step back, could you just remind us how many fulfillment centers you have in the single channel format versus the multi-channel format and where you see that shifting to over the next few years maybe?
Joe Doody
I don't have the number right at my fingertips here, but I think there's around a dozen that are single channel only today. Now that number will be reduced as we phase out of a few of them moving to multi-channel, but there will continue to be several single channel only facilities remain as a part of our organization long-term, because of the need with the size of the business, their geographical location, et cetera.
Some of those were locations that we actually purchased as a part of our acquisition of Quill. So we'll continue to grow the number of multi-channel facilities, but over the long haul, there will continue to be a few single channel only buildings that will remain out there.
Brad Thomas - Lehman Brothers
Okay. Thank you very much.
Operator
Our next question comes from the line of Brian Nagel - UBS.
Brian Nagel - UBS Warburg
If you can comment you showed a nice pick-up there in retail comps in the quarter. If you could talk about maybe the trend through the quarter that you saw in retail?
Ron Sargent
Yes. We don't talk about the kind of trends within a quarter, we just talk quarterly comps but I can tell you, particularly given the 1% comp that we announced last quarter, that we're very pleased with the rebound in our comps. This quarter we saw, as Mike has mentioned, strong growth in customers, good mix of consumables and durable comps. We saw good gross margin comps, improvements in furniture, really the best comps that we have seen in our business in over a year.
So what we're doing is really investing in the business and I'm happy to know that some of those investments that we made in the business over the last year are starting to pay off in the top line. I guess top line was 12% this quarter versus 9% last quarter.
Where it's coming from, I think we've mentioned all those, copy center, own brand, delivery, and even international sales growth is a little better than maybe we earlier thought in the quarter.
Brian Nagel - UBS Warburg
Just touching on the comps, you guys had, I think in previous analyst meetings, you talked about longer term potential for that business. Could you kind of give some idea of where we're tracking now in the copy center versus your longer term goals for the business?
Ron Sargent
Sure. I've always said that, and I'm not sure it's universally shared here at Staples, but I'm thinking at some point we could get to $1 million a store and that's a long way away from where are today. I guess we have been growing at a multiple of our comp growth but I think we're still in the $350,000 per store. I think the short-term or interim term goal, depending on your perspective, would be to get to that $600,000 to $650,000 range.
But I'm very bullish about this business and when you think that we've got copy centers in every store really in Staples, certainly every store in North America and I think virtually all the stores in Europe. I think there's huge, huge potential to grow our copy center business now that we're capable and able to compete with anybody out there.
Brian Nagel - UBS Warburg
Great. Nice quarter and good luck for the next one. Thanks.
Ron Sargent
Great. Thank you, Brian.
Operator
Our next question is a follow-up question from the line of Dan Binder.
Dan Binder - Buckingham Research Group
Hi. Just had a couple quick follow-ups based on your comments. In response to one of the questions, you talked about being able to reduce the wholesale exposure. I'm just wondering if you can give us an update on what percentage of your delivery sales are coming out of wholesale today and where you think that can go to?
Then the second question was, with a little bit earlier back-to-school launch, was there a number that you could quantify in terms of how that may have benefited the comp store sales gain?
Joe Doody
Yeah, Dan, not going to give you a percentage but I was the one that made the comment regarding our new buildings that with them higher SKU count, therefore, we can fill more orders ourselves without the use of the wholesaler. At the same time, we've seen our business with the wholesalers, a very good complimentary business to ours, slower moving SKUs that we have we will then send to the wholesaler as we continue to re-evaluate the flow of the products within our facility.
At the same time, we also work very closely to drive some category growth in areas where we don't stock those products and rely heavily on the wholesalers for that, i.e. furniture. So there are certain categories where we may not have as many of those SKUs stocked and as such rely more heavily on them and we'll continue to do that as well.
Ron Sargent
It's safe to say our wholesale purchases are probably up year-over-year.
Joe Doody
They're up, but not up in line with the growth of the overall business.
Dan Binder - Buckingham Research Group
Right. Any thoughts on the benefit of going back-to-school a little bit earlier this year? That seemed to be the smart decision?
Joe Doody
It was a smart decision. It seems like back-to-school seems to start earlier and earlier every year, Dan. As you know, it's a small number of early markets are actually back-to-school in the month of July. As far as the impact we're estimating roughly half a percent impact positive impact for the quarter.
Dan Binder - Buckingham Research Group
I was in some retail stores recently, not just Staples and was hearing from folks that worked there that there may be a certain amount of cherry picking that goes on with these weekly specials.
I'm just kind of curious what you're seeing in terms of the consumer behavior? Are you finding they come in for these really low price item and then sort of wait for the next wave of discounting or are you getting a complete basket when they come in on these promos?
Joe Doody
I think there might be a little bit of cherry picking, but for the most part we had really good offers out there along with other good products. There's a lot of brand new product that customers really want to get their hands on early in the season so probably a little bit of a combination of cherry picking as well as people who want to stock up, get the picks early and then be done with it.
Dan Binder - Buckingham Research Group
Okay, great. Thanks.
Operator
Ladies and gentlemen, this does conclude the question-and-answer portion of today's conference call. I'd like to turn the presentation back over to Mr. Ron Sargent for closing remarks.
Ron Sargent
Just to wrap up, I'd like to thank the Staples team for another strong quarter and a great first half of the year. We're very pleased to see our top line accelerate coupled with terrific service scores that show we're doing a great job with our customers. We're growing much faster than the industry, while remaining committed to balancing investments and growth and maintaining our focus on the bottom line and return on capital.
We've seen strong traffic in our North American retail business. We've seen continued momentum in our North American delivery business and we're seeing steady progress in Europe and I believe that 2006 is on track to be another great year for Staples.
Thank you all for calling in. Appreciate your time and your interest.
Operator
Ladies and gentlemen, thanks for your participation in today's conference call. This does conclude your presentation and you may now disconnect. Have a great day.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!